Holding

Appropriations for taxation, gratuity and proposed dividends are provisions, not reserves, and therefore must be excluded from capital computation under the relevant super‑profits tax statutes.

Summary

The Supreme Court examined whether sums appropriated by companies for taxation, retirement gratuity, and proposed dividends could be treated as "other reserves" for capital computation under the Super Profits Tax Act, 1963 and the Companies (Profits) Sur‑tax Act, 1964. It held that amounts set aside for taxation are provisions, not reserves, because they represent a known liability. The Court found that gratuity appropriations are provisions unless excess of a scientifically calculated liability is shown, and remanded that issue for factual determination. It further ruled that amounts earmarked for proposed dividends are merely provisions for payment and cannot be classified as reserves. Consequently, the Tribunal’s exclusion of these sums from capital computation was affirmed, the gratuity issue was remanded, and the appeals were largely dismissed.

Issues considered

Whether sums appropriated for taxation, retirement gratuity and proposed dividends qualify as "other reserves" under Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963 and the Companies (Profits) Sur‑tax Act, 1964.
Whether a provision for taxation constitutes a reserve for the purpose of capital computation.
Whether an appropriation to gratuity reserve is a provision or a reserve, and the effect of any excess over the actuarially estimated liability.
Whether an amount set aside for proposed dividend is a reserve or a provision for capital computation.

Legislation cited

Companies Act, 1913
Companies Act, 1956s. Regulation 87 (Table A, Schedule I), s. Regulation 99 (First Schedule), s. Section 210, s. Section 211, s. Section 217
Companies (Profits) Sur‑tax Act, 1964s. Rule 1 of Second Schedule, s. Section 18
Income Tax Act, 1961s. Section 256(1), s. Section 257
Super Profits Tax Act, 1963s. Rule 1 of Second Schedule, s. Section 2(5), s. Section 2(9)

Subjects

super profits taxreserve vs provisioncapital computationCompanies Actdividendgratuity provisiontaxation provisioncommercial accountancyinterpretation of statutesappealtax reference

Judgment

789 A
VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC.
v.
COMMISSIONER OF INCOME-TAX
ANDHRA PRADESH, HYDERABAD B
September 250 !981

• (V.D. TULZAPURKAR, E.S. VENKATARAMIAH AND
AMARENDRA NATH SEN, JJ.]

Super Profits Tax Act, 1963 and Company's (Profits) Sur-tax Act, 1964-
c
Ru/e I of Second Schedule-Scope of-'' Provision" and "Reserve"·-Distinction-
A sum of money transferred from current profits to general reserves-Dividend paid
from that fund-General reserve how calculated.

The Super (Profits Tax) Act, 1963 and the Company's (Profits) Sur-ta.
Act, 1964 (the scheme and main provisions of both of which are almost identical) D
impose a special tax on excess profits earned by companies. The special t~ is
imposed in respect of so much of a company's "chargeable profits" of the
previous year as exceeded the "standard deduction"- The term "chargeable
profit" is defined to mean th~ total income of an assessee computed under the
Income Tax Act, 1961 for aDy previous year and adjusted in accordance with
the provisions of that Act. "Standard deduction" is determined by computing
the capital of a company in accordance with the rules laid down in the schedule. E
The material part of rule 1 provides that before any amount or sum qualifies
for inclusion in capital computation of a company two conditions are required
to be fulfilled namely : (i) that the amount or sum must be a "reserve" and (b)
that it must not have been allowed .in computing the company's profit for the
purposes of Income Tax Acts, 1922 or 1961.

In their respective balance sheets, the assessees had shown under the heading F
"current liabilities and provisions" appropriations of large sums of money for
taxation, retirement gratuity and dividends and claimed that for the purposes of
1<uper profits tax these sums should be regarded as "other reserves" within the
meaning of Rule 1 of Second Schedule to the Act and that for the computation
of capital they should be taken into account .

• Treating these sums as "provisions" and not as "reserves", the Super
Profits Tax Officer determined the capital and the standard deduction by exclud~ G
ing them from the computation of the capital. He then levied super profits tax
on that portion of the chargeable profits of the previous year as exceeded the
standard deduction.

While the Appellate Assistant Commissioner upheld the assessee's contention ff
that these sums were "reserves" which should be taken into account for comput·
ing their capital, the Appellate Tribunal held that these were not "reserves" within
790 SUPREME COURT REPORTS [1982] I S.C.R.

the meaning of Rule 1 of the Second Schedule to the Act and as such could not
enter into capital computation.
I
On reference the High Court held that the sums set apart were not "reserves"
and so should be excluded in the computation of the capital for the purposes of
levying the super profits tax.

B In Tax Reference no. 5 (a case under the Companies (Profits) Sur-tax Act,
1964) the assessee transferred from out of its current profits a large sum of
money to the general reserves and paid dividend to its shareholders from out of
the augmented general reserves. On the question whether for computing the
capital for the purpose of sur-tax the general reserves should or should not be
reduced by the sum of dividend paid, the taxing authorities and the appeUate
tribunal ignored this amount holding that it was not a "reserve".
c
None of the items of appropriation either for taxation or for retirement
gratuity or for proposed dividend in the asses!!:ees' cases had been allowed in
computing their profits under the Income Tax Act, 1961.

HELD : [per Tulzapurkar & Venkataramiah, JJ] ~

D The expressions' 'reserve" and "provision" have not been defined in the
Act. Standard dictionaries, without making any distinction between the
two concepts, use them more or less S}nonymously connoting the same idea. But
since in the context of the legislation a clear distinction between the two is
implied it is essential to know the exact connotation of the two concepts and the
distinction as known in commercial accountancy. The rules for computation of
capital contained in the Second Schedule to the Act proceed on the basis of the
E formula of capital plus reserve, a formula well known in commercial accountancy.
But since they occur in a taxing statute applicable to companies only these
expressions will have to be understood in the sense or meaning attributed to the1n
by men of business, trade and commerce and by persons interested in or dealing
with companies. Therefore, the meaning attached to these words in the Com-
panies Act, 1956 would govern their construction for the purpose of these two
enactments. [800 C·H]
F
The broad distinction between the two expressions as judicially evolved by
this Court is that, while a "provision" is a charge against the profits to be taken
into account against gross receipts in the profit and loss account, a "reserve" is .,.,
an appropriation of protits, the· asset or assets by which it is represented being
retained to form part of the capital employed in the business. [801 F]
G C.l.T. v. Century Spinning & Manufacturiag Co., 24 ITR 499 and Metal Box
Company of India Ltd. v. Their Workmen, 13 ITR 67 followed.

The Cornpanies Act, which enjoins upon the Board of Directors of every
company to lay before the annual general meeting of its shareholders an annual
H balance sheet and a profit and loss account, enumerates the separate heads that
should be shown in the balance sheet, two of these items being "reserve" and
"provision". The definitions of these two expressions given in the Act show
VAZJR SULTAN TOBACCO CO. V. C.J.T. 791

that if any retention or appropriation of a sum falls within the definition of A
"provision" it can never be a "reserve", But the converse is not true. If the reten-
tion or appropriation is not a "provision" that is, if it is not designated to meet
depreciation, renewals or diminution in value of assets or any known liability it is
not automatically a ''reserve'' and the question will have to be decided having
regard to the true nature and character of the sum so retained or appropriated
depending on several factors, including the intention with which and the purposes
for which such retention or appropriation had been made. [803 E·F] 8
'.
Having regard to the type of definitions of the two concepts, if a particular
retention or appropriation of a sum falls within the expression "provision" then
that sum will have to be excluded from the computation of capital. If the sum
is in fact a "reserve" then it would be taken into account for the computation
of capftal. l804 B-C]
c
Where the assessee had set apart a sum of money to meet tax liability in
respect of profits earned during an accounting year, which liability was not
quantified, such setting apart for a known and existing liability, would be a
"provision" and could not be regarded as a "reserve". [806 A-C]

Kesorarri Industries and Co1ton Mills Ltd. v. Commissioner of Wealth Tax D
(Central) Caicutta, 59 JTR 767 followed.

But if provision for a known or existing liability is made in excess of the
amount reasonably necessary for the purpose, such excess shou1d,,.be treated as
"reserve" and, therefore, would be includible in capital computation. [806 E]

Since the assessee (in C.A. No. 860/73) had at no stage of the proceedings
E
before the Taxing Authorities or Appellate Tribunal or the High Court raised a
plea that the provision made by it for taxation was in excess of the amount
reasonably necesssary for the purpo~e and that such excess should be treated as a
"reserve'', the olea which needs investigation into facts, could not be allowed to
be raised for the first time in appeal before this Court. [807 F]
F
Ordinarily an appropriation to gratuity reserve will have to be regarded as
a provision made for a contingent liability, for, under a scheme framed by a
company- the 1iability to pay gratuity to its employee on determination of employ-
ment arises only when the employment of the employee is determined by death,
incapacity, retirement or resignation-an event (cessation of employment) certain
• to happen in the service career of every employee. Moreover, the amount of
gratui1y payable is usuaJJy dependent on the employee's wages at the time of G
determination of his employment and the number of years of service put in by
him and the liability accrues and enhances wilh completion of every year of
service; but the company can work out on an acturial valuation its estimated
liability (i.e. discounted present value of the liability under the scheme on a sden~
tific basis) and make a provision for such liability not all at once but spread over
t\ number of years. Jf by adopting such scientific method any appropriation is H
,.. made such appropriation will constitute a provision representing fairly accurately
a known and existing liability for the year in question; if however, an ad hoc sum
792 SUPREME COURT REPORTS [1982] I S.C.R.

A is appropriated without resorting to any scientific basis such appropriation would
also be a provision intended to meet a known liability, though a contingent one,
for, the expression 'liability' occurring in cl. (7)(1)(a) of Part III of Sixth Schedule I
to the Companies Act includes any expenditure contracted for and arising
under a contingent liability; but if the sum so appropriated is shown to be in
excess of the sum required to meet the estimated 1iability (discounted present
value on a scientific basis) it is only the excess that will have to be regarded as a
B reserve under clause (7) (2) of Part III to the Sixth Schedule. [807 G·H; 808 A·D]

In the instant case although the assessee had urged before the authorities
below that different treatment for the same item could not be given for purposes
of income tax assessment and super profits tax assessment the assessee did not
clarify by placing material on record as to whether appropriation was based on
any acturial valuation or whether it was an appropriation of an ad hoc amount
0 which has a vital bearing on the question, whether the appropriation could be
treated as a provision or reserve. In the absence of proper material the question
should be decided by the taxing authorities whether the amount set apart and
transferred to gratuity reserve by the assessee company was either a provision or
a reserve and if the latter to what extent. [812 C·E]

Standard Mills Co. Ltd. v. Commissioner of Wealth.Tax, Bombay. 63, I.T.R.
D 470 & Work,,,.n of William Jacks & Co. Ltd. v. Management of Jacks & Co.
Ltd; Madras, [1971] Supp. S.C.R. 450 followed.

Southern Railway of Peru Ltd. v. Owen [1957] A.C. 334 referred to.

The appropriations of an amount by the Board of Directors by way of
providing for proposed dividend would not constitute 'provision', for, the appro·
E priations cannot be said to be by way of providing for any known or existing
liability, none having arisen on the date when the Directors made recommenda-
tion much less on the relevant date after the first day of the previous year
relevant to the assessment year in question. This by itself would not convert
the appropriations into "reserves•·. [813 E·F]

F The tests and guidelines laid down by this Court in this respect are : (1) the
true nature and character of the appropriation must be determined with reference
to the substance in the matter, which means that one must have regard to the
intention with which and the purpose for which appropriation has been made
such intention and purpose being gathered from the surrounding circumstances.
A mass of undistributed profits cannot automatically become a reserve. Some
body possessing the requisite authority must clearly indicate that a portion •
G thereof has been earmarked or separated from the general mass of profits with a
view to constituting it either a general reserve or a specific reserve; (2) the
surrounding circumstances should make it apparent that the amount so earmark·
ed or set apart is in fact a reserve to be utilised in future for a specific purPose
on a specific occasion; (3) a clear conduct on the part of the Directo1s in setting
apart a sum from out of the mass of undistributed profits avowedly for the
H purpose of distribution of dividend in the same year would run counter to a~y
intention of making that amount a reserve, (4) the nomenclature accorded to any
particular fund which is set apart from out of the profits would not be material
VAZJR SULTAN TOBACCO CO. v. C.J.T. 793
or decisive of the matter; and (5) if any amount set apart from out of the profits A
' is going to make up capital fund of the assessee and would be available to the
assessee for its business purposes it would become a reserve liable to be included
in the capital computation of the assessee under that Act. [815 F·H, 817 G]

The relevant provisions of the Companies Act clearly show that Jcreating
reserves out of the profits is a stage distinct in point of fact and anterior in point
of time to the stage of making recommendation for payment of dividend and the 8
scheme of the provisions suggests that appropriation made by the Board of
Directors by way of recommending a payment of dividend cannot in the nature
• of things be a reserve. [818 F-G]

Judged in the light of the above guidelines the ~·appropriations made by the
Directors for proposed dividend in the case of the concerned assessee companies
did not constitute 'reserves' and the :concerned amounts so set apart would have C
to be ignored or excluded from capital computation. [818 H]

Standard Mills Co. Ltd. v, Commissioner of Wealth-tax Bombay, 63 I.T.R.
470, Metal Box Co. of India Ltd. v. Their Workmen, 73 ITR 67, First National
City Bank v. Commissioner of Income-Tax, 42 ITR 67 & Commissioner of Income-
tax (Central), Calcutta v. Standard Vacuum Oil Co., 59 !TR 685 followed.
D
Although under the Companies Act it is open to the Directors to recom-
mend and the share-holders to approve payment of dividend from the current
year's profits or from the past year's profits and on transfer of a portion of
the current year's profit to the general reserve the augmented general reserve
becomes a congolmerate fund, having regard to the natural course of human
conduct it is not difficult to predicate that dividends would ordinarily be paid
out from the current income rather than from the past savings, unless the E
directors in their report expressly or specifically state that payment of divid~nds
would be made from the past savings. From the commercial point of view, if
any amount is required for incurring any expenditure or making any disburse-
ment like distribution of dividends in a current year, ordinarily the same will
come out of the current income of the company if it is available and only if the
sum is insufficient then the past savings will be resorted to for the purpose of
incurring that expenditure or making that disbursement. Such a course would F
be in accord with the common sense point of view. [822 C-F]
.• In the absense of express indication to the contrary the normal rule for a
comn1ercial concern would be to resort to current income rather than past
savings while incurring any expznditure or making any disbursement. (822 H]

Commissioner of Income-Tax, Bambay City-Iv. Bharat Bijlte Ltd. 107 ITR G
30; & Comniissioner of Income-Tax, Bombay City-I/ v. Marrior (India) Ltd. 120
!TR 512 approved.

[per A.N. Sen, J.]
H
The amount set apart for payment of any dividend recommended by the
Board of Directors is not an amount set apart for meeting a known or existing
794 SUPREME COURT REPORTS [1982] I S.C.R.

A liability and cannot be considered to be a "reserve" within the meaning of the
Act for the purposes of computation of the capital of the company. [832 F] I

The Companies Act, 1956 provides for the preparation of annual b1l1nce
sheet in the psescribed form and laying it before the shareholders at the annual
general meeting. Regulation 87, Table A in Schedule I contemplates that the
Board may set aside out of the profits of the cotnpany certain sum as "reserve"
B before dividend is recommended by it. The amount recommended by the Board
for payment of dividend is shown in the balance sheet under the head "provision°
and not under any head of ''reserve!'. The true nature and character of the sum
so set apart must be determined with regard to the substance of the matter which
in this case is that the sum set apart \Vas never intended to constitute a "reserve"
of the company. [833 F, 834 G]

c In law the liability for payment of dividend arises only when the share·
holders accept the recommendations made by the Directors. Till then it is open
to the Directors to modify or withdraw their recommendation before it is accepted
by the shareholders and it is equally open to the shareholders not to accept the
recommendation in its entirety. Even so, for business purposes when the
Directors make any recommendation for payment of dividend and set apart any
amount for this purpose the Directors intend to make a provision and do not
D create any reserve, as Directors know that their recon1rnendation is generally
accepted by the shareholders as a matter of course. T11erefore any amount set
apart for this purpose is understood by persons interested in company matters
and in dealing with companies to mean a provision for the payment of dividend
to the shareholders and is not understood to constitute a "reserve". [832 C- E]

Commissioner of Income-tax Bombay City v. Century Spinning and Manu·
E facturing Co. Ltd. [19531 24 I.T.R. 499, Commissioner of Income Tax v. Standard
Vaccum Oil Co., [1966] 59 I.T,·R. 685, Metal Box Co. of Ltd. v. Their Workmen,
[1963] 73 I.T.R, 53, Commissioner of Income-tax v. Mysore Electrical Industries
Ltd., [1971] 80 I.T.R. 567 and Kesha Ram Industries and Cottun Mills Ltd v.
Commissioner of Wealth Tax (Central), Calcutta, [1966] 59 I.T.R. 767 referred to.

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 860 of 1973.
F
From the judgment and order dated the I st September, 1972 of
the Andhra Pradesh High Court at Hyderabad in R.C. No. IO of
1971.

AND
G
Civil Appeal No. 1614 (NT) of 1978.

Appeal by Special Leave from the judgment and order dated
the 26th July, 1976 of the Calcutta High Court in J.T. Reference No.
454 of 1974.
H
AND
Review Petition No. 57 of 1980.
VAZIR SULTAN TABACCO CO. v. C.l.T. 795

IN A
Special Leave Petition (Civil) No. 4602 of 1977

From the judgment and order dated the 11th June, 1974 of the
Calcutta High Court in I.T. Reference No. 195 of 1969.

AND B
•
Tax Reference Case Nos. 2 and 3 of 1977.

Income-tax Reference under section 257 of the Income-tax Act,
1961 drawn up by the Income-tax Appellate Tribunal, Bombay
Bench 'B' in R.A. Nos. 1223 and 1224 (Born.) of 1972-73 (J.;T. A.
Nos. 24 and 25 (Born.) of 1971-72.
c
AND
Tax Reference Case No. 5 of 1978.

Income Tax Reference under section 257 of the Income Tax D
Act, 1961 made by the Income Tax Appellate Tribunal, Bombay
Bench "D" in R.A. No. 225 (Born.) of 1977-78 arising out of S.T.A.
No. 36 (Bombay)/ 1976-77.

A. Subbarao and Y.V. Anjaneyulu for the appellant in Civil
~~~8~n. E
V.S, Desai, Dr. ~Debi Pal, Praveen Kumar and Anil Kumar
Sharma for the Appellant in C.A. 1614of1978 and for the Petitioner
in Review Petition No. 57 /80.

K.G. Haji and K.J. John for the Appellant in Tax Reference F
Case Nos. 2 and 3 of 1977.
. S.E. Dastur, S.N. Ta/war and K.J. John for the Appellant in
Tax Reference Case No. 5 of 1978.

S.T. Desai, J. Ramamurthi and Miss A. Subhashini for the G
Respondent in Civil Appeal No. 860/73.

Miss A. Subhashini for the Respondent in Civil Appeal No.
1614 of 1978.
H
,.. S.C. Manchanda and Miss A. Subhashini for the Respondent in
Tax Reference Nos. 2 and 3 of 1977.
796 SUPREME COURT REPORTS (1982] 1 S.C.R.

A S.C. Manchanda, Ani/ Dev Singh and Miss A. Subhashini for
the Respondent in Tax Reference Case No. 5/ 1978. I

SP. Mehta and K.J. John for the Intervener.

· Dr. Debi Paul and K.J. John for the Intervener in Tax
B Reference Case No. 5/1978.
•
The following Judgments were delivered :

TULZAPURKAR, J. In these Civil Appeals and Tax Reference
Cases certain common questions of law arise for our determination
c and hence all these are disposed of by this common judgment. The
common questions raised are whether amounts retained or appro-
priated or set apart by the concerned assessee company by way of
making provision (a) for taxation, (b) for retirement gratuity and
(c) for proposed dividends from out of profits and other surpluses
could be considered as "other reserves" within the meaning of Rule
D 1 of the Second Schedule to the Super Profits Tax Act, 1963 (or
Rule I of the Second Schedule to the Company's (Profits) Sur-tax
Act, 1964) for inclusion in capital computation of the Company for
the purpose of levying super profit tax? The first three matters
concerning Vazir Sultan Tobacco Co. L1d; Hyderabad, Ballarpur
lndustries, Ltd; and M/s. Bengal Paper Mills Co. Ltd; Calcutta arise
E under the Super Profits Tax Act, 1963 while the the Tax Reference
Cases concerning M/s. Echjay Industries Pvt. Ltd. and Hyco Pro-
ducts Pvt. Ltd. Bombay arise under the Companies (Profits) Sur-tax
Act,! 964.

Since Civil Appeal No. 860 of 1973 (Vazir Sultan Tobacco
F
Company's case) is compreher,sive and comprises all the three items
of apprc priation it will be sufficient if the facts in this case are set
out in detail so as to understand how the questions for determination
arise in these matters. Vazir Sultan Tobacco Co. Ltd. was an
assessee under the Super (Profits) Tax Act, 1963. For the assess- •
G ment year 1963-64, for which the relevant accounting period was the
year which ended 30th September, 1962, for computing the chargea-
ble profits ot that year for the purpose of levy of super profits tax
under the Act, the assessee company claimed that the appropriations
of a) Rs. 33,68,360 for taxation, (b) Rs. 9,08,106 for retirement
H gratuity and (c) Rs. 18,41,820 for dividends (all of which items
were shown under the heading 'current liabilities and provisions' in
the concerned balance-sheet as at 30th Sept. 1962) should be regar-
VAZIR SULTAN TOBACCO co. v. C.I.T. (Tulzapurkar, J.) 797

ded as "other reserves" within the meaning of Rule 1 of Second A
Schedule to the Act and be included while determining its capital.
The Super Profits Tax Officer rejected the assessee's contention as
in his opinion all these items were "provisions'· ~nd not "reserves"
and as such these had to be ignored or excluded from the capital
computation of the assessee company and on that basis he deter·
mined the capital, and the standard deduction and levied super B
•
profits tax on that portion of the chargeable profits of the previous
year which exceeded the standard deduction. In the appeal prefer-
red by the assessee company against the assessment, the Appellate
Commissioner upheld the assessee's contentions and held that tho3e
items were "reserves" and took them into account while computing
the capital of the assessee company. In the further appeal prefer- c
red by the Super Tax Officer, the Income Tax Appellate Tribunal
accepted the Department's contention and held that these were not
"reserves" within the meaning of Rule I of the Second Schedule to
the Act and as such these could not enter into capital computation
of the assessee company. In the Reference that was made under
section 256(1) of the Income Tax Act, 1961 read with s. 10 of the D
Super Profits Tax Act at the instance of the assessee company the
following question of law was referred to the Andhra Pradesh High
Court for its opinion :

"Whether on the facts and in the circumstances of the
case the provisions (a) for taxation Rs. 33,68,360, (b) for E
retirement gratuity Rs. 9,08,106 and (c) for dividends
Rs. 18,41,820, could be treated as 'reserves' for computing
the capital for the purpose of super profits tax under
Second Schedule to the Super Profits Tax Act, 1963 for the
assessment year 1963-64 ?"
F
The High Court on a consideration of several authorities
answered the question in respect of the three items in favour of the
Revenue and against the assessee company and held that the three
snms so set apart by the assessee company in its balance-sheet were
not "reserves" and had to be excluded in the computation of its
capital for the purpose of levying super profits tax payable on the
G
chargeable profits for the relevant accounting year. It is this view
of the High Court that is being challenged by the assessee company
in the Civil Appeal No. 860 of 1973 before us.
H
In Civil Appeal No. 1614/1978 (Ballarpur Industries Ltd) a1d
Review Petition No. 57 of 1980 (M/s. Bengal Paper Mills Co. Ltd.)
798 SUPREME COURT REPORTS [1982] 1 s.c.R.

A 'l\e are concerned with only two items of appropriation being (a)
provision for taxation and (b) provision for proposed dividend and
I
in each one of these cases the Calcutta High Court had taken the
view that these two items do not constitute "reserves" and as such
have to be ignored while computing the capital of the assessee
company.
B
In Tax Reference Case Nos. 2 and 3 of 1977 (M/s Echjay Indu- •
stries Pvt. Ltd.)- a case under Companies (Profits) Surtax Act, 1964,
we are concerned with two items of appropriation being (a) provision
for taxation (b) provision for proposed dividend for the two assess-
ment years 1969-70 and l 970-71 and in each of the years the Taxing
c Authorities as also the Income Tax Appellate TribunalB ombay have
taken the view that these appropriations did not constitute "other
reserves" within the meaning of Rule I of the Second Schedule to
the Companies (Profit) Surtax Act, 1964 and as such were not
includible in the capital computation of the assessee company but in
D view of a divergence of opinion between the different High Courts
on the point, the Tribunal has at the instance of the assessee
company made a direct Reference to this Court under s. 257 of the
Income Tax Act, 1961 read with s. 18 of the Companies (Profits)
Surtax Act, l %4.

In Tax Reference Case No. 5 of 1978 (Hyco Products Pvt.
E Ltd.) - also a case under Companies (Profits) Surtax Act, 1964 the
same question pertaining to dividend alone but in a different form
arose for consideration before the Taxing Anthorities and the Income
Tax Appellate Tribunal. It was not a case of 'proposed dividend'
but the assessee company after transferring Rs. 29,77,000 out of the
current year's profit amounting to Rs. 61,03,382 to General Reserves,
F
paid out of Rs. 3, I 0,450 as dividend to its share-holders from such
augmented General Reserves and the question was whether while
computing the capital of the assessee-company for the purpose of
levy of surtax the General Reserves should or should not be reduced
by the aforesaid sum of Rs. 3,10,450? In other words, the ques-
fion was whether the amount of Rs. 3,10,450 could not form part
G of the General Reserves on the relevant date (being I.I. 1973) for
the computation of the capital ? The Taxing Authorities as well as
the Appellate Tribunal Bombay held that the said amount of
Rs. 3,10,450 had to be ignored for the purpose of computation of
capital for surtax purposes because it was not a reserve. The
H assessee company has challenged this view of the Tribunal before us
in this direct Reference made to this Court under s. 257 of the
...
VAZIR SULTAN TOBACCO co. v. C.1.T. (Tulzapurkar, J.) 799

Income Tax Act, 1961 read with s. 18 of the Companies' (Profits) A
Surtax Act, 1964.

It may be stated that the scheme aud the main prov1S1ons of
the two concerned enactments are almost identical, the object of both
these enactments being the imposition of a special tax on excess profits
earned by companies. Under Section 4 of the 1963 Act, which is the 8
charging provision, there shall be charged on every company for every
assessment year commencing on and from !st April, 1963, a tax,
called the super profits tax, in respect of so much of its "chargeable
profits" of the previous year as exceed the "standard deduction" at
the rate or rates specified in the Third Schedule. Section 2(5) defines
the expression "chargeable profits" to mean the total income of an c
assessee computed under the Income Tax Act, 1961, for any previous
year and adjusted in accordance with the provisions of First Sche-
dule, while Section 2(9) defines the expression "standard deduction"
to mean an amount equal to six per cent of the capital of company as
computed in accordance with the provisions of the Second Schedule,
or an amount of Rs. 50,000 whichever is greater. In order to 0
determine "standard deduction". it becomes necessary to compute
capital of the company in accordance with the rules laid down in the
' Second Schedule and rule I is relevant for our purposes, the material
portion whereof runs as follows :

"I. Subject to the other prov1s10ns contained in this
E
Schedule, the capital of a company shall be the sum of
the amounts, as on the first day of the previous year
relevant to the assessment year, of its paid up share
capital and of its reserve, if any, credited under the
proviso (b) to Clause (vi-b) of sub-section (21 of sec.
JO of the Indian Income Tax Act, 1922 or under sub-
F
section (3) of sec. 34 of the Income Tax Act, 1961, and
of its other reserves in so far as the amounts credited
r
to such other reserves have not been allowed in com-
puting its profits for the purposes of the Indian Income
Tax Act, 1922 or the Income Tax Act, 1961 ......... "
G
It will be clear from the aforesaid provision of rule l that
before any amount or sum qualifies for inclusio,1 in capital compu ·
tation of a company two conditions are required to be fulfilled-(a)
that the amount or sum must be a "reserve" and (b) the same must
H
not have been allowed in computing the company's profits for the
purposes of the 1922 Act or the 1961 Act. That none of the items
800 SUPREME COURT REPORTS (1982] I s.c.R.

A of appropriation either for taxation or for retirement gratuity, or
for proposed dividend in the concerned assessees' case had been
I
allowed in computing the assessee's profits under the 1961 Act has
not been disputed; in other words the second condition indicated
above has been satisfied. The question is whether any of these items
could be treated as or falls within the expression "other reserves"
B occurring in the said rule.

The expression 'reserve' has not been defined in the Act and
therefore one would be inclined to resort to its ordinary natural
meaning as given in the dictionary but it seems to us that the
dictionary meaning, though useful in itself, may not be sufficient,
c for, the dictionaries do not make any distinction between the two
concepts 'reserve' and 'provision' while giving their primary mea-
nings whereas in the context of the legislation with which we are
concerned in the case a clear distinction between the two is implied.
According to the dictionaries (both Oxford and Webster) the appli-
cable primary meaning of the word 'reserve' is : "to keep for future
D use or enjoyment; to set apart for some purpose or end in view; to
keep in store for future or special use; to keep in reserve", while
'provision' according to Webster means : "something provided for
future." In other words according to the dictionary meanings both
the words are more or less synonymous and connote the same idea.
Since the rules for computation of capital contained in the Second
E Schedule to the Act proceed on the basis of the formula of capital
plus reserves-a formula well-known in commercial accountancy, it
becomes essential to know the exact connotation of the two concepts --
'reserve' and 'provision' and the distinction between the two as
known in commercial accountancy. Besides, though the expression
'reserve' is not defined in the Act, it cannot be forgotten that it
F occurs in a taxing statute which is applicable to companies only and
to no other assessable entities and as such the expression will have
to be understood in its ordinary popular sense, that is to say, the ,
sense or meaning that is attributed to it by men of business, trade
and commerce and by persons interested in or dealing with com-
panies. Therefore, the meanings attached to these two words in
G the provisions of the Companies Act 1956 dealing with preparation
of balance-sheet and profit and loss account would govern their
construction for the purposes of the two taxing enactments. We
might mention here that in C.I.T. v. Century Spinning and Manu-
facturing Company(') this Court after referring to the dictionary
H
(J) 24 I.T.R. 499.
VAZIR SULTAN TOBACCO co. v. C.l.T. (Tultapurkar, J.) 801

meaning of the expression 'reserve' observed : "what is the true A
nature and character of the disputed sum (sum allegedly set apart)
must be determined with reference to the substance of the matter"
and went on to determine the true nature and character of the dispu-
ted sum by relying upon the provisions of the Indian Companies Act
1913, the form and the contents of the balance-sheets required to be
drawn up and Regulation 99 in Table A of the I st Schedule.. B
•
""' The distinction between the two concepts of 'reserve' and
• 'provision' is fairly well-known in commercial accountancy and the
same has been explained by this Court in Metal Box Company of
India Ltd. v. Their Workmen (1) thus :
c
"The distinction between a provmon and a reserve
is in commercial accountancy fairly well known. Provi-
sions made against anticipated losses and contigencies are
charges against profits and therefore, to be taken into
account against gross receipts in the P. and L. account and
the balance-sheet. On the other hand, reserves are appro- D
priations of profits, the assets by which they are represen-
ted being retained to form part of the capital employed in
the business. Provisions are usually shown in the balance-
sheet by way of deductions from the assets in respect of
which they are made whereas general reserves and reserve
funds are shown as part of the proprietor's interest. (See E
-- Spicer and Pegler's Book-keeping and Accounts, 15th
Edition, page 42)".

In other words the broad distinction between the two is that whereas
a provision is a charge against the profits to be taken into account
against gross receipts in the P and L account, a reserve is an appro- F
priation of profits, the asset or assets by which it is represented being
retained to form part of the capital employed in the business.
Bearing in mind the aforesaid broad distinction we will briefly
indicate how the two concepts are defined and dealt with by the
Companies Act, 1956. G
Under s. 210 of the Companies Act, 1956 it is incumbent
upon the Board of Directors of every company to Jay before the
annual general meeting of its share-holders (a) the annual balance-
sheet and (b) the profits and Joss account pertaining to the previous
B
(I) 73 I.T.R. 67.
802 SUPREME COURT REPORTS (1982) I S.C.R.

A financial year. Section 211(1) provides that every balance-sheet of
a company shall give a true and fair view of the state of affairs of
the company as at the end of the financial year and shall, subject to
the provisions of this section, be in the form set out in Part I of
Schedule VI, or near thereto as circumstances admit or in such other
from as may be approved by the Central Government either gener-
B ally or in any particular case, while s. 211(2) provides that every
profit and loss account of a company shall give a true and fair view
of the profit or loss of the company for the financial year and shall,
subject as aforesaid, comply with the requirements of Part II of
Schedule VI, so far as they are applicable thereto. In other words
the preparation of balance-sheet as well as profit and loss account
c in the prescribed forms and laying the same before the share-holders
at the annual general meeting are statutory requirements which the
company has to observe. The Form of balance·sheet as given in
Part I of Schedule VI contains separate heads of 'reserves and
surpluses' and 'current liabilities and provisions' and under the
D sub-head 'reserves' d,ifferent kinds of reserves are indicated and
under sub-head 'provisions' different types of provisions are indi-
cated; Part III is the interpretation clause setting out the definitions
of various expressions occurring in Parts I and II and the expressions
'reserve', 'provision' and 'liability' have been defined in cl. 7 thereof.
Material portion of cl. (7) of Part III runs as under :
E
"(l) For the purposes of Parts I and II of this Sche-
dule, unless the context otherwise requires :

(a) the expression "provision" shall, subject to sub·
F cl. (2) of this clause mean any amount written off
or retained by way of providing for depreciation,
renewals or diminution in value of assets, or re-
tained by way of providing for any known liability
of which the amount cannot be determined with
substantial accuracy;

G (b) the expression "reserve" shall not, subject as
aforesaid, include any amount written off or
retained by way of providing for depreciation,
renewals or diminution in value of assets or re-
tained by way of providing for any known liability;
H
(c) x x x x
VAZIR SULTAN TOBACCO co. v. c.I.T. (Tulzapurkar, J.) 803

and in this sub-clause the expression "liability" shall include A
all liabilities in respect of expenditure contracted for and
all disputed or contingent liabilities.

(2) Where--

(a) any amount written off or retained by way of B
•
providing for depreciation, renewals or diminution
in value of assets, not being an amount written off
in relation to fixed assets before the commence-
ment of this Act; or

(b) any amount retained by way of providing for any C
known liability;

is in excess of the amount which, in the opmion of the
directors, is reasonably necessary for the purpose, the
I
excess shall be treated for the purposes of this Schedule as
a 'reserve' and not a 'provision'." D

On a plain reading of cl. 7(1) (a) and (b) and cl. 7(2) above it
will appear clear that though the term 'provision' is defined positively
by specifying what it means the definition of 'reserve' is negative in
form and not exhaustive in the sense that it only specifies certain
E
amounts which are not to be included in the term 'reserve'. In
-- other words the effect of reading the two definitions together is that
if any retention or appropriation of a sum falls within the definition
of 'provision' it can never be a reserve but it does not follow that
if the retention or appropriation is not a provision it is automati-
cally a reserve and the question will have to be decided having
F
regard to the true nature and character of the sum so retained or
appropriated depending on several factors including the intention
with which and the purpose for which such retention or appropria-
tion has been made because the substance of the matter is to be
regarded and in this context the primary dictionary meaning of the
term 'reserve' may have to be availed of. But it is clear beyond
G
doubt that if any retention or appreciation of a sum is not a pro-
vision, that is to say, if it is not designated to meet depreciation,
renewals or diminution in value of assets or any known liability the
same is not necessarily a reserve. We are emphasising this aspect
of the matter because during the hearing almost all counsel for the
H
assessees strenuously contended before us that once it was shown
or became clear that the retention or appreciation of a sum out of
804 SUPREME COURT REPORTS (1982) 1 S.C.R.

A profits and surpluses was for an unknown liability or for a liability
which did not exist on the relevant date it must be regarded as a
reserve. The fallacy underlying the contention becomes apparent I
if the negative and non-exhaustive aspects of the definition .of reserve
are borne in mind. Having regard to type of definitions of the
two concepts which are to be found in cl. 7 of Part. III the proper
B approach in our view, would be first to ascertain whether the parti-
cular retention or appropriation of a sum falls within the expression •
'provision' and if it does then clearly the concerned sum will have
to be excluded from the computation of a capital, but in case the
retention or appropriation of the sum is not a provision as defined
the question will have to be decided by reference to the true nature
c and character of the sum so retained or appropriated having regard
to several factors as mentioned above and if the concerned sum is
in fact a reserve then it will be taken into account for the computa-
I
tion of capital.

Having thus indicated the proper approach to be adopted, we
D shall proceed to deal with the three items of appropriation being (a)
provision for taxation, (b) provision for retirement gratuity and
(c) provision for proposed dividends in the case of concerned
assessee companies in these Appeals and Tax Reference Cases.

Dealing first with the item of appropriation by way of pro·
E
vision for taxation, which arises in Civil Appeal No. 860/I 973
(Vazir Sultan Tobacco Company), Civil Appeal No. 1614 (NT)/
1978 (Ballarpur Industries Ltd;) Review Petition No. 57/1980 (M/s.
Bengal Paper Mills Co. Ltd.) and Tax Reference Cases Nos. 2 &
3/1977 (M/s Echjay Industries Pvt. Ltd;)-the common question is
whether the concerned amounts appropriated or set apart by these
F
assessee-companies from out of the profits and other surpluses by
way of making provision for taxation constitute a provision or a
reserve on the relevant date, being the first day of the previous year
relevant to the assessment year in question? Taking Vazir Sultan
Tobacco Company's case as an illustration, for the assessment year
G 1963-64 the relevant accounting period was the year which ended on
September 30, 1962; under Rule I of the Second Schedule to the
Super Profits Tax Act, the first day of the previous vear would be
October I, 1961 and. theref.Jre, the balance-sheet of that company
as on September 30, 1961 and the profits and loss account which
H er.ded on September 30, 1961 would be relevant. It cannot be
disputed that on the expiry of September 30, 1961, the assessee
company incurred the taxation liability in respect of the profits
VAZIR SULTAN TOBACCO co. v. C.I.T. (Tulzapurkar, J.) 805

which it had earned during that year, though the exact amount of A
such liability could not be determined with substantial accuracy at
that time and the same would have to be ascertained by reference
to rate of taxes applicable to that year. The liability for taxation
having thus arisen on the expiry of the last day of the year, the
setting apart of the sum of Rs. 33,68,360 by the Board of Directors
will have to be regarded as a provision for a known and existing B
liability, the quantification whereof had to be done later. On
principle, therefore, it seems to us clear that the item of Rs. 33,68,360
which had been set apart by the Board of Directors for taxation
must be regarded as a provision and cannot be regarded as a reserve.
Similar would be the position in regard to the appropriations for
taxation made by the other assessee-companies mentioned earlier. c
In this context a reference to this Court's decision in the
case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of
j Wealth Tax (Central) Calcutta(') would be useful. In that case the
question was whether a certain amount which had been set apart as
provision for payment of income-tax and super tax was a "debt D
owed" within the meaning of s. 2(m) of the Wealth-Tax Act, 1957,
as on March 31, 1957 which was the valuation date and as such
' was deductible in computing the net wealth of the appellant company.
In its balance-sheet for the year ending March 31, 1957 the appellant
company had shown a certain amount as provision for payment of
Income-tax and super-tax in respect of that year of account and this E
-- .,.,- Court took the view that the expression "debt owed" within the
meaning of s. 2(m) of the Wealth-Tax Act, 1957 could be defined
as the liability to pay in presenti or in futuro an ascertainable sum
of money and that the liability to pay income-tax was a present
liability though the tax became payable after it was quantified in
accordance with ascertainable data; that there was a perfected debt
F
on the last date of the accounting year and not a contingent liability.
The Court further observed that the rate was always easily ascertain-
able; that if the Finance Act was passed, it was the rate fixed by that
Act; if the Finance Act was not yet passed, it was the rate prnposed
in the Finance Bill pending before the Parliament or the rate in force
G
in the preceding year whichever was more favourable to the assessee
and that all the ingredients of a "debt" were present and it was a
present liability of an ascertainable amount and that, therefore, the
amount of provision for payment of income-tax and super-tax in
respect of the year of account ending March 31, 1957 was a "debt H
(1) 59 J.T.R. 767.
806 SUPREME COURT REPORTS [1982) I S.C.R.

A owed" within the meaning of s. 2(m) on the valuation date, namely
March 31, 1957 and was as such deductible in computing the net
wealth. The ratio of this deci>ion clearly suggests that the appro-
priation of the amounts set apart by the assessee companies before
us for taxation would constitute a provision made by them to meet
a known and existing liability and as such the concerned amounts
B would not be includible in capital computation.

Counsel for the assessee company in Vazir Sultan Tobacco
Company's case, however, attempted to raise a further plea that
the provision for taxation in the sum of Rs. 33,68,360 was an excess

0
provision in the sense it was in excess of the amount which was
reasonably necessary for the purpose of taxation and, there ore, the
excess should be treated as a reserve and not a provision and in
this behalf reliance was placed on cl. (7) (2) of Part III of Schedule
-
VI and three decisions-of the Madras High Court Commissioner of
Income-tax Madras v. Indian Steel Rolling Mills Ltd.( 1) of the
Himachal Pradesh High Court in Hotz Hotels Pvt. Ltd. v. Commis-
D sioner of Income Tax, Haryana, H.P. and Delhi(') and of Allahabad
High Court in Commissioner of Income-Tax, Delhi v. Modi Spinning
and Weaving Mills('). There could be no dispute about the principle
that if provision for a known or existing liability is made in excess
of the amount that would be reasonably necessary for the purpose
the excess shall have to be treated as a reserve and, therefore, would
E be includible in the capital computation but no such case was made
out by the assessee company at any stage of the assessment pro-
ceedings either before the Taxing Authorities or even before the
Tribunal or the High Court and in the absence of any such plea
having been raised at any stage of the proceedings it will not be
proper for this Court to allow the assessee company to raise such
F a plea, which will need investigation into facts, for the first time in
its appeal before this Court. The contention is, therefore, rejected.

Dealing next with the item of appropriation made for retire-
ment gratuity, which arises only in Civil Appeal No. 860/1973
(Vazi; Sultan Tobacco Co.) the question is whether the sum of
G Rs. 9,08, I06 appropriated or set apart by the assessee company
from out 01 its profits and other surpluses by way of providing for
retirement gratuity is a provision or a reserve on the relevant date,

H (I) 92 !TR 78.
(2) 101 !TR 596.
(3) 117 !TR 23.
VAZIR SULTAN TABACCO co. v. C.I.T. (Tulzapurkar, J.) 807

viz. l.I0.!96!? Counsel for the assessee-company vehemently A
urged before us that this appropriation had not been allowed
as a deduction in the income-tax assessment proceedings of the
company for the relevant assessment year on the ground that it was
in the nature of a reserve and the entire sum, minus the actual
payments, was added back to the income and profits of the assessee-
company and if that be so, in the super profit-tax assessment it B
cannot be treated as a provision and excluded from capital compu-
tation. Accordiag to him there could not be two different treat-
• ments for the same item in income·tax assessment and super profit-
tax assessment. He pointed ant that this contention was specifically
urged in the appeal before the Appellate Assistant Commissioner
but was wrongly rejected. He further submitted that no actuarial c
valuation had been undertaken but ad hoc amount was appropriate
or transferred to gratuity reserve and as such the same shoe Id have
been treated as a reserve and included in capital computation. On
; the other hand, counsel for the Revenue seriously disputed the last
submission and contended that it was never the case of the assessee-
company either before the Taxing Authorities or before the Tribunal 0
or before the High Court that the appropriation was of an ad hoc
sum without undertaking any actuarial valuation. It must be
observed that whereas the assessee-company did urge a contention
before the lower authorities that different treatments for the same
item could not be given for purpose of income-tax assessment and
super profit-tax assessment, the assessee company did not clarify by
E
placing material on record as to whether the appropriation of the
amount was based on any actuarial valuation or whether it was an
appropriation of an ad hoc amount an aspect which, as we shall
presently point out, has a vital bearing on the question whether
the appropriation could be treated as a provision or a reserve. In
F
the absence of proper material touching this vital aspect, we are
afraid, the issue in question will have to be remanded to the Taxing
Authorities through the Tribunal for disposal in the light of the well
settled principles in that behalf, which we shall presently indicate.

Ordinarily an appropriation to gratuity reserve will have to be G
regarded as a provision made for a contingent liability, for, under
a scheme framed by a company the liability to pay gratuity to its
employees on determination of employment arises only when the
employment of the employee is determined by death, incapacity,
retirement or resignation-an event (cessation of employment) H
certain to happen in the service career of every employee; moreover,
the amount of gratuity payable is usually dependent on the emp-
808 SUPREME COURT REPORTS [1982] 1 S.C.R.

A loyee's wages at the time of determination of ~,jg employment and
the number of years of service put in by him and the liability
accrues and enhances with completion of every year of service; but
the company can work out on an actuarial valuation its estimated
liability (i.e. discounted present value of the liability under the scheme
on a scientific basis) and make a provision for such liability not all at
B once but spread over a number of years. It is clear that if by
adopting such scientific method any appropriation is made such
appropriation will constitute a provision representing fairly accurately
a known and existing liability for the year in question; if, however,
an ad hoc sum is appropriated without resorting to any scientific
basis such appropriation would also be a provision intended to meet
c a known liability, though a contingent one, for, the expression
'liability' occurring in cl. (7) (1) (a) of Part III of the Sixth Schedule
to the Companies Act includes any expenditure contracted for and
arising under a contingent liability; but if the sum so appropriated
is shown to be in excess of the sum required to meet the estimated
liability (discounted present value on a scientific basis) it is only the
D excess that will have to be regarded as a reserve under cl. (7) (2) of
Part III to the Sixth Schedule.
Jn the above context we might refer to one English case '
decided by the House of Lords and two or three decisions of this
Court, which seem to lead to aforesaid propositions. In Southern
E Railway of Peru Ltd. v. Owen(') an English Company operating a
railway in Peru was, under the laws of that country, liable to pay
its employees compensation on the termination of their services
either by dismissal or by notice or on such termination by death or
effiux of contractual time. The compensation so paid was an amount
equivalent to one month's salary at the rate in force at the date of
F determination for every year of service. In the computation of
taxable income under the Income-tax Act 1918, the company claimed
to be entitled to charge against each year's receipts the cost of mak-
ing provision for the retirement payments which would ultimately be
thrown on it, calculating the sum required to be paid to each
employee if he retired without forfeiture at the close of the year and
{j setting aside the aggregate of what was required in so far as the
year had contributed to the aggregate. The House of Lords
rejected the deductions on the ground that in calculating the
deductions the company had ignored the factor of discount.
But, their Lordships recognised the principle that the company was
H entitled to charge, against each year's receipts, the cost of making the

(I) [1957] A.C. 334.
VAZIR SULTAN TOBACCO v. C.!.T. (Talzapurkar, J.) 809

provision for the retirement which would ultimately be payable as A
the company had had the benefit of the employee's services during
that year provided the present value of the future payments could be
fairly estimated. Lord MacDermott observed at page 345 as follows:

" ..... as a general proposition it is, I think right to say
that, in computing his taxable profits for a particular year, 8
• a trader, who is under a definite obligation to pay his
employees for their services in that year an immediate
• payment and also a future payment in some subsequent
year, may properly deduct, not only the immediate pay-
ment but the present value of the future payment, pro-
vided such present value can be satisfactorily determined or c
fairly estimated."

In Standard Mills Co. Ltd. v. Commissioner of Wealth-Tax,
.. ! Bombay (') the question for decision was whether an estimated
liability under gratuity schemes framed under industrial awards
amounted to 'debts' and could be deducted while computing the net 0
wealth of the assessee-company under the Wealth Tax Act. This
Court held in view of the terms of s. 2 (m) of that Act, that as the
liability to pay gratuity was not in praesenti but would arise in future
on determination of the service, i. e. on the retirement, death or
termination, the estimated liability under the schemes would not be a
'debt' and, therefore, could not be deducted while computing the E
net wealth. The House of Lords decision in the case of Southern
Rly. of Peru Ltd. (supra) was distinguished by this Court as having
no relevance to the question before it on the ground that the House
of Lords in that decision was concerned in determining the deducti-
bility of the present value of a liability which may arise in future in
F
the computation of taxable income for the relevant year under the
income-tax laws. It will thus appear that this Court was of the view .
that though such a liability is a contingent liability and, therefore,
not a 'debt' under s. 2(m) of the Wealth-Tax Act it would be deduc-
tible under the Income Tax Act while computing the taxable profits;
in other words different considerations would apply to cases arising
G
under the Wealth-Tax Act and the Income-Tax A.ct.

In Metal Box Co's case (supra) this Court was concerned with
the nature of liability under a scheme of gratuity in the context of
the Payment of Bonus Act, 1965 and the question related to a sum H

(!) 631.T.R. 470.
810 SUPREME COURT REPORTS [ 1982) I S.C.R.

A of Rs. 18.38 lakhs being the estimated liability under the two gratuity
schemes framed by the company, which was deducted from the gross f
receipts in the P & L Account, it being contended on behalf of the
workmen that such deduction was not justified wbile determining the
'available surplus' and the 'allocable surplus' for payment of bonus
to them under the Payment of Bonus Act, 1965. The Court rejected
B the contention and adverting to the decision of House of Lords in •
the case of Southern Rly. of Peru Ltd. (supra) held that an estimated
liability under gratuity schemes even if it amounted to a contingent
liability and was not a 'debt' under the Wealth Tax Act, if properly
ascertainable and its present value was fairly discounted was deducti-
ble from the gross-receipts while preparing the P & L Account. The
c material portion of the head-note appearing at page 54 of the report
runs thus

"Contingent liabilities discounted and valued as neces-
sary, can be taken into account as trading expenses if they ,_
' <•
are sufficiently certain to be capable of valuation and if
D profits cannot be properly estimated without taking them
into consideration. An estimated liability under a scheme
of gratuity, if properly ascertainable and its present value is
discounted, is deductible from the gross receipts while pre-
paring the P & L account. This is recognised in trade
circles and there is nothing in the Bonus Act which prohi-
E bits such a practice. Such a provision provides for a known
liability of which the amount can be determined with subs-
tantial accuracy. It cannot, therefore, be termed a "reserve".
Therefore, the estimated liability for the year on account of
a scheme of gratuity should be allowed to be deducted from
the gross profits. The allowance is not restricted to the
F
actual payment of gratuity during the year."

At page 62 of the Report this Court observed thus :

"Two questions, therefore, arise: (l) whether it is legiti-
G mate in such a scheme of gratuity to estimate the liability on
an actuarial valuation and deduct such estimated liability in
the P & L A/c while working out its net profits; (2) if it is,
whether such appropriation amounts to a reserve or a provi-
sion? ...... In the case of an assessee maintaining his accounts
H on mercantile system, a liability already accrued, though to
be discharged at a future date, would be a proper deduction
while working out the profits and gains of his business, re-
VAZIR SULTAN TOBACCO v. C.I.T. (Tulzapurkar, J.) Sll

gard being had to the accepted principle of commercial A
practice and accountancy . It is not as if such deduction is
permissible only in case of amounts actually expended or
paid. Just as receipts, though not actual receipts but
accrued due, are brought in for income-tax assessment, so
also liabilities accrued due would be taken into account
while working out the profits and gains of the business" . B
•
Again at page 64 of the Report this Court observed thus :
•
"In the instant case the question is not whether such

- estimated liability arising under the gratuity schemes amou-
nts to a debt or not. The question that concerns us is
whether while working out the net profits, a trader can pro-
vide from bis gross receipts his liability to pay a certain
c
sum for every additional year of service which he receives
from his employees. This, in our view, he can do if such
f liability is properly ascertainable and it is possible to
arrive at a proper discounted present value. Even if the D
liability is a contingent liability, provided its discounted
present value is ascertainable, it can be taken into account.
Contingent· liabilities discounted and valued as necessary
can be taken into account as trading expenses if they are
sufficiently certain to be capable of valuation and if profits
cannot be properly estimated without taking them into
account.''

In the case of Workmen of William Jacks & Co. Ltd. v. Mana-
gement of Jacks & Co. Ltd. Madras (1) another decision under the
Payments of Bonus Act, 1965, this Court, after referring to the dis·
tinction pointed out in Metal Box Co's case between the two concepts F
'provision' and 'reserve' has observed on page 547 as follows :

"The provision for gratuity, furlough salary, passage,
service and commission, in the present case was all made in
respect of existing and known liabilities though in some
cases the amount could not be ascertained with accuracy. It G
was not a case where it was an anticipated loss or anticipa-
ted expenditure which would arise in future. Such provision
is therefore not a reserve at all and cannot be added back
under item 2 (c) of the Second Schedule."

(1) [1971] (Supp.) S.C.R. 405.
812 SUPREME COURT REPORTS [1982) I S.C.R,

A In the above case also the Court was concerned with the ques-
tion whether particular provision made for gratuity, furlough salary,
passage, etc. was a reserve or a provision for the purpose of Second
Schedule to the Payment of Bonus Act, 1965. At page 546 of the
report the Court has categorically observed that all these items,
namely, gratuity furlough salary, passage, service, commission, etc.
B were clearly in respect of liabilities which had already accrued in the
years in which the provision was made and were not in respect of •
anticipated liabilities which might arise in future and, the1 efore, the
Court held that the said provision was not a reserve but a provision. •

c
From the aforesaid discussion of the case law it seems to us
clear that the propositions indicated by us earlier clearly emerge.
Since in the instant case sufficient material throwing light on the
above aspects of the question has not been made available, we think,
-
it will be in the interest of justice to remand the case through the
Tribunal to the taxing authority to decide the issue whether the con-
cerned amount (Rs. 9,08,106/-) set apart and transferred to gratuity
D reserve by the assessee company was either a provision or a reserve
and if the latter to what extent? The taxing authority will decide
the issue in light of the above principles after giving an opportunity
to the assessee company to place additional relevant materials before ,
it.
E Turning to the last i tern of appropriation by way of provision
for proposed dividends, which arises in all these matters (except in
Tax Reference Case No. 5/1978 of Hyco Products Pvt. Ltd.) the
common question is whether the concerned amount appropriated or
set apart by the assessee-companies from out of the profits and
other surpluses by way of making provision for 'proposed dividends'
F constituted a provision or a reserve on the relevant date?

It is true that under s. 27 of the Companies Act, 1956 the
Directors can merely recommend that a certain sum be paid as divi-
dend but such recommendation does not result in any obligation or
liability; the obligation or liability to pay the dividend arises only
G
when the share-holcers at the annual general meeting of the company
decide to accept the recommendation and pass a resolution for
declaration of the dividend. It is therefore open to the directors to
withdraw or modify their recommendation at any time before the
shareholders accept the same and it is equally open to the sharehol-
H ders not to accept the recommendation at all or to declare a'' dividend
of an amount lesser than that recommended by directors. In Kesoram
VAZIR SULTAN TOBACCO v. C.l.T. (Tulzapurkar, J.) 813

Industries case (supra) this Court has clarified the aforesaid legal A
position by observing at page 772 of the report, thus :

"The directors cannot distribute dividends but they
can only recommend to the general body of the company
the quantum of dividend to be distributed. Under section
B
.. 217 of the Indian Companies Act, there shall be attached to
every balance-sheet laid before a company in general meet-
ing a report by its board of directors with respect to, inter
alia, the amount, if any, which it recommends to be paid by
way of dividend. Till tbe company in its general body
meeting accepts the recommendation and declares the divi-
dend, the report of the directors in that regard is only a
recommendation which may be withdrawn or modified as
the case may be. As on the valuation date (under the
Wealth Tax Act) nothing further happened than a mere
recommendation by the directors as to the amount that
might be distributed as dividend, it is not possible to hold
that there was any debt owed by the assessee to the share- D
holders on the valuation date."

All that follows from above is that in the instant cases the
appropriations of the concerned amounts by the Board of Directors
by way of providing for proposed dividend would not constitute
'provisions' for, the appropriations cannot be said to be by E

- way of providing for any known or existing liability, lnone
having arisen on the date when the directors made the recommenda-
tion much less on the relevant date being the first day of the previous
year relevant to the assessment year in question. But as stated ear-
lier this by itself would not automatically convert the appropriation
into 'reserves', regard being had to the negative and non-exhaustive F
character of the definition of 'reserve' given in cl. 7 (I)(b) of Part III
of the Sixth Schedule to the Companies A ct. The question whether
the concerned amounts in fact constituted 'reserves' or not will have
to be decided by having regard to the true nature and character of
the sums so appropriated depending on the surrounding circum-
G
stances particularly the intention with which and the purpose for
which such appropriations had been made.

We have already indicated that according to the dictionaries
(both Oxford and Webster) the applicable meaning of the word B
'reserve' is: "to keep for future use or enjoyment; to set apart for
some purpose or end in view; to keep in store for future or special
814 SUPREME COURT REPORTS [l 982) ] S.C.R.

A use; to keep in reserve." In other words, the word 'reserve' as a
noun in ordinary parlance would mean "something which is kept
for future use or stored up for something or set apart for some pur-
pose". It cannot be disputed that a reserve may be a general
reserve or specific reserve and all that is required is that an amount
should be kept apart for some purpose, either general or specific.
B Even so the question is whether the earmarking of a portion of pro-
fits by the board of directors of a company avowedly for the purpose
..
of distributing dividend would fall within the expression 'reserve'
occurring in rule I of the Second Schedule to the Super Profits Tax
Act, 1963? For this purpose certain tests indicated in some decisions
of this Court will have to be considered :
c
The first decision of this Court in that behalf is the decision in
Century Spinning and Manufacturing Company's case (supra). In
that case the material facts were these : For the year ending 31st
December, 1945, the profit of the assessee-company, whose account-
ing year was the calendar year, was a certain sum according to the
D profit and loss account. After making provision for depreciation
and taxation, the balance of Rs. 5,08,637 was carried to the balance
sheet. This sum was not allowed in computing the profits of the
assessec for the purposes of income tax. On 28th February, 1946,
the Board of directors recommended out of that amount the sum of
Rs. 4,92,426 should be distributed as dividend and the balance of
E
Rs. 16)11 was to be carried forward to the next year's account.
This recommendation was accepted by the share-holders in their
meeting on 3rd April, 1946, and the amount was shortly afterwards
distributed as dividend. In computing the capital of the assessee
-
company on 1st April, 1946, under the Business Profits Tax Act,
1947, the assessee claimed that the sum of Rs. 5,08,637 and the
F profit earned by it during the period I st January, 1946 to I st April,
1946, should be treated as "reserves" for the purpose of rule 2(1) of
Schedule II. The High Court held that the sum of Rs. 5,08,637 must
be treated as a reserve for the purpose of rule 2, but the profit made
by the assessees during the period 1st January, 1946 to !st AlJril,
G 1946 could not be included in the reserves. On appeal to this Court,
it was held that the sum of Rs. 5,08,637 as well as the profits earned
by the assessee during the period 1st January, 1946 to !st April, 1946
did not constitute "reserves" within the meaning of rule 2 (I) of
Schedule II. After noting that the expression 'reserve' had not been
defined in the Business Profits Tax Act, 1947 and after noting dic-
H tionary meanings of that expression the Court observed :
VAZIR SUl,,TAN TOBACCO V. C.J.T. (Tulzapurkar, J.) 815

"What is the true nature and character of the disputed A
sum must be determined with reference to the substance of the
matter and when this is borne in mind, it follows that the
!st of April, 1946 which is the crucial date, the sum of
Rs. 5,08,637 could not be called a reserve for nobody pos-
sessed of the requisite authority had indicated on that date
the manner of disposal or destination. On the other hand, B
on the 28th February, 1946 the directors clearly earmarked it
for distribution as dividend and did not make it a reserve.
Nor did the company in its meeting of 3rd April, 1946
decide that it was a reserve. It remained on the 1st of April,
as a moss of undistributed profits which were available for
distribution and not earmarked as "reserve". On the !st c
of January, 1946 the amount was simply brought from the
profit and loss account to the next year and nobody with
any authority on that date made or declared a reserve. ;.The
reserve may be a general reserve or a specific reserve, but
there must be a clear indication to show whether it was a
reserve either of the one or the other kind. The fact that D
it constituted a mass of undistributed profits on the I st Jan.
1946 cannot automatically make it a reserve. On the Ist
April, 1946 which is the commencement of the chargeable
accounting year, there was merely a recommendation by the
directors that the amount in question should be distributed
as dividend. Far from showing that the directors have E
made the amount in question a reserve it shows that they had
decided to earmark it for distribution as dividend."

The decision clearly Jays down that tbe true nature and charac-
ter of the appropriation must be determined with reference to the
substance of the matter; obviously this means that one must have F
regard to the intention with which and the purpose for which appro-
priation bas been made, such intention and purpose being gathered
from the surrounding circumstances. In that behalf the following
aspects mentioned in the judgment provide some guidelines : (a) a
mass of undistributed profits cannot automatically become a reserve
and that somebody possessing the requisite authority must clearly
G
indicate that a portion thereof has been earmarked or separated from
the general mass of profits with a view to constituting it either a
general reserve or a specific reserve, (b) the surrounding circums-
tances should make it apparent that the amount so ear-marked or
set apart is in fact a reserve to be utilised in future for a specific
H
purpNe and on a specific occasion, and (c) a clear conduct on the
816 SUPREME COURT REPORTS [1982] J S.C.R.

A part of the directors in setting apart a sum from out of the mass of
undistributed profits avowedly for the purpose of distribution as
dividend in the same year would run counter to any intention of
making that amount a reserve. It was because these aspects obtained
in the case that this Conrt took the view that neither the sum of
Rs. 5,08,637 nor the profits earned by the assessee during the period
B lst January, 1946 to lst April 1946 constituted "reserve" within the
meaning of Rnle 2(1) of Second Schedule of the Business Profits Tax
Act, 1947.
Two more decisions of this Court one in First National City
Bank v. Commissioner ofIncome-Tax(') and the other in Commiss-
ioner of Income-Tax (Central), Calcutta v. Standard Vacuum Oil Co.(')
c which provide two more guidelines, may now be considered. In
both these cases the Court was concerned with the question whether
the amount set apart as "undivided profit'' or set apart as "earned
surplus" in accordance with the system of accountancy which ob-
tained in the United States amounted to a reserve liable to be
included in the capital computation under rule 2 of Schedule II of
D the Business Profits Tax Act, 1947. In both the cases the assessees
were non-resident companies and followed the system · of accounting
that obtained in the American commercial world. In the first case
Justice Kapur, speaking for the court, pointed out the difference bet-
ween the two system of accounting at page 23 of the Report thus :

E "In India at the end of an year of account the unallo-
cated profit or loss is carried forward to the account of the
next year, and such unallocated amount gets merged in the
account of that year. In the system of accounting in the
-
USA each year's account is self-contained and nothing is
carried forward. lf afteral locating the profits to diverse
F heads mentioned above any balance remains, it is credited
to the "undivided profits" which become part of the capital
fund. If in any year as a result of the allocation there is
loss the accumulated undivided profits of the previous years
are drawn upon and if that fund is exhausted the banking
company draws upon the surplus. In its very nature the
G undivided profits are accumulation of amounts of residue
on hand at the end of the year of successive periods of
accounting and these amounts are by the prevailing accoun-
ting practice and the Treasury directions regarded as a
part of the capital fund of the banking company."

(1) 42 ITR 17.
(2) 59 ITR 685.
VAZIR SULTAN TOBACCO v. C.l.T. (Tulzapurkar, J.) 817

After quoting with approval the above observations, Mr. A
Justice Shah in Standard Vacuum Oil Co.'s case went on to observe
at page 695 of the report as follows :

"It is true that the court in that case was dealing
with a case of a banking company but the charac-
teristics noted are not peculiar to the accounts of a banking 8
company; they are applicable with appropriate variations
to the accounts of all companies in which different nomen-
clatures are used in the accounts to designate the residue
on hand as 'surplus', 'undivided profits' or 'earned surplus'.

Where the balance of net profits after allocation to c
specific reserves and payment of dividend are entered in the
account under the caption 'earned surplus', it is intended
thereby to designate the fund which is to be utilised for the
purpose of the business of the assessee. Such a fund may
I
be. regarded according to the Indian practice as 'general
[)
reserve'."

This Court in the first case held that the amount designated as
"undivided profits" which was available for continuous future use
of the business for the bank was a part of the reserve and had to be
taken into account while computing the capital under rule 2(1) of
Schedule II of the Business Profits Tax Act; similarly, in the second E
case the Court held that the amount which had been allocated to
"earned surplus" which was intended for the purpose of the business
of the assessee company and was used in subsequent years in
business, represented "reserves" within the meaning of rule 2 of
Schedule II of the Business Profits'1Tax. From these two decisions
two aspects emerge very clearly. In the first place, the nomenclature F
accorded to any particular fund which is set apart from out of the
profits would not be material or decisive of the matter and secondly,
having regard to the purpose of rule of 2 of Schedule II of the
Business Profits Tax Act, 1947, if any amount set apart from out of
the profits is going to make up capital fund of the assessee and
would be available to the assessee for its business purposes, it would G
become a reserve liable to be included in the capital computation of
the assessee under that Act.

The provisions of the Companies Act 1956 also lend support
to the proposition that an appropriation for proposed dividend
H
would not amount to a reserve. Section 217(1) runs thus:
818 SUPREME COURT REPORTS [1982] ] S.C.R,

A "217(1) There shall be attached to every balance sheet
laid before a company in general meeting, a report by its
Board of directors, with respect to-
•
(a) the state of the company's affairs;

(b} the amounts, if any which it proposes to carry to
B any reserves in such balance sheet,
,

(c) the amounts, if any, which it recommends should
be paid by way of dividend;

(d) ...................................................... "
c Regulation 87 of Table A in the First Schedule runs thus :

"87(1) The Board may, before recommending any divi-
dend, set aside out of the profits of the company such sums
as it thinks proper as a reserve or reserves which shall, at
the discretion of the Board, be applicable for any purpose
D to which the profits of the company may be properly
applied, including provision for meeting contingencies or
for equalising dividends; and pending such application may /·
at the like discretion, either be employed in the business of ' '
the company or be invested in such investments (other than
shares of the company) as the Board may, from time to •
E time, think fit.
(2) The Board may also carry forward any profits
which it may think prudent not to divide, without setting
them aside as a reserve."

F The aforesaid provisions read together clearly show that creating re-
serves out of the profits is a stage distinct in point of fact and anterior
in point of time to the stage of making recommendation for payment
of dividend and the scheme of the provisions suggests that appro-
priation made by the Board of Directors by way of recommending
a payment of dividend cannot in the nature of things be a reserve.
G
If regard be had to the guide-lines indicated above as well as
the provisions of the Companies Act 1956 specified above we are
clearly of the opinion that the appropiations made by the directors
for proposed dividend in the case of the concerned assessee-com-
H panies do not constitute 'reserves' and the concerned amounts so set
apart would have to be ignored or excluded from capital compu-
tation.
VAZIR SULTAN TOBACCO v. C.I.T. (Tulzapurkar, J.) 819

Since we have reached the aforesaid conclusion on first princi- A
ples and on the basis of the guidelines discussed above it is
unnecessary for us to go into or discuss the scope and effect of the
Explanation to Rule 1 in Second Schedule to The Companies
(Profits) Sur-tax Act, 1964 though it seems to us prime facie that
the Explanation, being clarifacatory in nature is declaratory of the
existing legal position. B
Dealing with the last case of Hyco Products Pvt. Ltd. Bombay
(Tax Reference Case No. 5 of 1978), where the question pertaining
to dividend but in a different form arises for consideration, the
admitted facts may brieJly be stated. The question relates to the
Assessment Year 1974-75, the relevant previous year being calendar c
year 1973 and the material date being 1.1.1973. After the accounts
of the calendar year 1972 were finalised the directors transferred out
of the profits of Rs. 61,03,382 of that year a sum of Rs. 29,77,000
to the General Reserve. With such tranfer the General Reserve of
!
the assessee company as on 1.1.1973 stood at Rs. 86,07,712. At the
end of the calendar year, 1973 admittedly the directors did not D
make any provision for 'proposed dividend' in its accounts but
there was note on the Balance Sheets to the following effect :-

"The directors have recommended dividend for the
year 1972 at the rate of Rs. 10/- per share free of tax. The
dividend, if approved by the share-holders at the forth- E
coming Annual General Meeting, will be paid out of
General Reserve and no separate provision has been made
therefor in the accounts."

At the Annual General Meeting held on June 30, 1973 dividend of
Rs. 3,10,450 was declared by the share-holders and the same was F
soon thereafter paid out of the said General Reserve. In the sur-
tax assessment proceedings under the 1964 Act the assessee claimed
that the entire general reserve which stood as Rs. 86,07, 712 as on
1.1.1973 should be taken into account while computing the capital
of the assessee company. But the taxing officer reduced the general
reserves by the aforesaid sum of Rs. 3,10,450 and only the balance G
of Rs. 82,97,262 was added in computing the capital. The Appellate
Assistant Commissioner as well as the Income-Tax Appellate
Tribunal, Bombay confirmed the order of the Taxing Officer.
The Tribunal took the view that though it was not a case of 'pro-
posed dividend' since the amount actually paid out as dividend was - H
a smaller sum than the amount transferred from out of profits to
820 SUPREME COURT REPORTS [1982] 1 s.c.R.

A the General Reserve that amount could not form part of the reserve
and therefore the General Reserve as reduced by Rs. 3,10,450 was
properly taken into account for the purpose of computation of the
capital as on the relevant date. At the instance of the assessee the
Tnbunal has referred the following question of law directly to this
Court for its opinion under s. 257 of the Income Tax Act 1961
B read withs. 18 of the Companies (Profits) Sur-tax Act, 1964: >

"Whether on the facts and in the circumstances of the
case the Tribunal was justified in excluding a sum of
Rs. 3,10,450 representing the dividends declared for the
calendar year 1972 from the General Reserves on the
c opening date of the previous year while computing the
capital under the Second Schedule of the Companies
(Profits) Sur-tax Act, 1964 for the assessment year 1974-75?"

Counsel for the assessee-company contended that after con-
ceding that this was not a case of "proposed dividend" the Tribunal
D erred in holding that the sum of Rs 3,10,450 representing the
dividends paid out from the General Reserve was liable to be
excluded while computing the capital of the company as on 1.1.1973
for purposes of sur-tax assessment under the 1964 Act. According •
to him under s. 205(1) of the Companies Act, 1956 dividend can be
paid from out of the current year's profits or profits of any previous
E financial year or years and there is no presumption in law or in
commercial accounting that a dividend has to be paid either from
the current year's profits or from the past year' s profits. He fnrther
urged that once from out of the current year's profits a certain sum
is transferred to the General Reserve it merges into the latter and
the General Reserve so augmented becomes a conglomerate fund
F and if out of such conglomerate fund any sum is recommended or
paid out as dividend it will be difficult to say that such payment has
come out oL the portion of current year's profits that has been
transferred and merged and there is no reason why the principle
'Last-in, First-out' should be invoked for drawing the inference that
the payment has been made out of the current year's profits. He
G pointed out that such a principle was applied by the Bombay High
Court in two decisions, namely, Commissioner of Income-Tax,
Bombay City·! v. Bharat Bij/ee Ltd.( 1) and Commissioner of Tncome-
Tax, Bombay City-Tl v. Marrior (India) Ltd.(') but urged that there

H
(!) 107 !TR 30.
(2) 120 !TR 512.
VAZIR SULTAN TOBACCO v. C.I.T. (Tulz"purkar, J.) 821

was no warrant for it. In support of his contention that the entire A
. General Reserve of Rs. 86,07,712 without any deduction should
have been taken into account while computing the capital of the
assessee-company, counsel relied upon a decision of the Andhra
Pradesh High Court in Super Spinning Mills Ltd. v. Commissioner of
JncomeTax, Hyderabad(').
B
Alternatively counsel pointed out that as far as stock valuation
is concerned a question often arises whether the stock on hand at
the end of the year is to be valued at the closing price or at the
initial purchase price and in 'Advanced Accounting' by R. Keith
Yorston and E. Bryan Smyth (a treatise on the principles and
practice of accounting in Australia) three methods of valuing the c
closing stock have been indicated at pages 441 and 442 of Vol.
II (5th Edn.) of the treatise, namely, (a) First-in First-out, (b) Last-
in First-out and (c) Average Cost. In regard to these three methods
the authors have stated thus .

(a) Pirst-in firs1-out D
The assumption underlying this method is that
the oldest stock is used or issued first or that sales are
' made in the order in which the goods are purchased
or produced. If there are several lots of goods at
different prices, they are regarded as being exhausted E
in the order of pnrchase. On a rising market this
would write off the lower-priced lots first, and on a
falling market the higher-priced lots would go first."

(b) "Last-in First-out.

This method assumes that the items of stock F
purchased are the first to be issued or sold and thus
the stock remaining is valued at the cost of the earlier
purchase."

(c) Average Cost.
G
On this basis issues of stocks are valued at the
weighted average cost of the stock on hand at the
beginning and of the purchases, less any issues already
made."
H
(!) 107 !TR 35.
822 lroi'REM~ COURT REPORTli {1982] I S.C.R.

A Counsel for the assessee urged that for determining whether the
entire General Reserve of Rs. 86,07,712 or reduced General Reserve
of Rs. 82,97,262 should be taken into account for capital compu-
tation either the 'First-in First-out' principle should be adopted;
if not, only a proportionate deduction should be made and the
balance should be held to be includible in capital computation,
B particularly because the payment of dividend has been from a
>
conglomerate fund.

It is not possible to accept either of these contentions urged
by counsel for the assessee-company. It is true that under s. 205(1)
of the Companies Act, 1956 it is open to the directors to recommend
G and the share-holders to approve payment of dividends either from
the current year's profits or from the past year's profits. It is also
true that on transfer of a portion of current year's profits to the
General Reserve the augmented General Reserve becomes a con-
glomerate fund but having regard to the natural course of human
conduct of hard-headed men of business and commerce it is not
D
difficult to predicate that the dividends would ordinarily be paid
out from the current income rather than from the past savings
unless the directors in their report expressly or specifically state
that payment of dividends would be made from the past savings.
From the commercial point of view if any amount is required for
incurring any expenditure or making any disbursement like distri-
E
bution of dividends in a current year, then ordinarily the same will
come out of the current income of the company if it is available
and only if the same is insufficient then the past savings will be
resorted to for the purpose of incurring that expenditure or making
that disbursement; such a course would be in accord with the
F common sense point of view. We may point out that this aspect
of the matter was not considered by the Andhra Pradesh High
Court in Super Spimdng Mills Ltd. case (supra) and the view of the
Bombay High Court in the case of Bharat Bijlee Ltd. (supra) and
Marrior (Indio) Ltd. (supra) commends itself to us. Even in regard
to the question of valuing the closing stock the learned authors of
G the treatise referred to by the counsel for the assessee-company
merely indicate three methods for such valuation and it will be
open to a commercial concern to avail of any one method. In our
view in the context of the question whether while incurring any
expenditure or making any disbursement a commercial concern will
H resort to current income or past savings, the normal rule, in the
absence of express indication to the contrary, would be to resort to
the current income rather than past savings.
VAZIR SULTAN TOBACCO v. C.l.T. (A.N. Sen, J.) 823

In our view, therefore, the Tribunal was right in excluding the A
sum of Rs. 3,10,450 from the General Reserves while computing
the capital of the assessee-company for the assessment year 1974-75,
in the absence of express indication to the contrary.

In the result Civil Appeal No. 1614(NT) of 1978 and Review
Petition No. 57 of 1980 are dismissed. Civil Appeal No. 860 of B
1973 is partly allowed and the issue whether the appropriation for
retirement gratuity is a reserve or not is remanded to the Taxing
\
Authority and the rest of the appeal is dismissed. In Tax Reference
Cases Nos. 2 and 3 of 1977 and No. 5 of 1978 the questions referred
to us are answered in favour of the Department and against the
assessee-companies. Each party will bear its own costs in all the c
matters.

AMARENDRA NATH SEN, J. At the outset I wish to observe
that I have been somewhat diffident in hearing these matters. I felt
I a little embarrased as I found that as a Judge of the High Court at
Calcutta, I had an occasion to consider some of the questions in the
D
case of Braithwaite and Co. (Indio) Ltd. v. Commissioner of Jncome-
Tax, West Bengal, (') (Tncomc Tax Reference No. 262 of 1969).
As I have already considered some of the questions and have expres-
sed my views on the same in the judgment delivered by me in the
said reference, I was wondering whether I should hear these appeals.
The members of the Bar. however, represented to me that they had
not only no objection to my hearing these appeals but they also
wanted me to hear these appeals. They further represented that
most of the Judges of this Court had on some occasion or other
considered these questions. They further stated that if I would
decline to take up these matters not only the members of the Bar
who had come from various parts of the country for these appeals F
would be seriously inconvenienced; but also the litigant public who
had been waiting for years for the hearing of these matters would
be prejudiced. It was further pointed out to me that the judgment
which was delivered by me was not under appeal and further it
would appear from the judgment which I had earlier delivered in
Braithwai1e matter, there was in fact a concession made by the G
learned counsel appearing on behalf of the assessee that the said case
was covered by the decision of the Supreme Court in the case of
Commissioner of Income· tax Bombay City v. Century Spinning and
Manufacturing Co. Ltd. (1) The learned counsel appearing on behalf
H
(1) [1978) III !TR 727.
(2) [1953) 24 !TR 499.
824 SUPREME COURT REPORTS (1982] I S,C.R

A of the parties further represented to me that the earlier judgment was
delivered by me as a Jndge of the High Court and it was always
open to me to reconsider my view, particularly as a Judge of •
this Court after bearing the submissions to be made by the learned
counsel appearing on behalf of the parties. In view of the
aforesaid representations and submissions made by the learned
8 lawyers, I was persuaded to hear these appeals with my learned
brothers to avoid inconvenience not only to the lawyers but to the
litigant pnblic. I have also had no doubt in my mind that if I felt
'
after hearing the submissions made by the learned counsel appearing
on behalf of the parties in these appeals, that the earlier judgment
delivered by me was wrong and incorrect, I would have no hesitation
c in reconsidering my earlier decision.

I do not propose to set out the facts of this case at any length
in this judgment. The facts have been fully and correctly set out in
the judgment of my learned brother Tulzapurkar, J. My learned
D brother in his judgment has also dealt with the various arguments
which were advanced from the Bar and has also considered the
decisions which were cited.

I propose to notice only some of the decisions which, to my
mind, are particularly important for decision of the question whether
E the provision made in the balance-sheet for payment of dividend to
the share-holders recommended by the Board of Directors constitut·
ed a 'reserve' and the amount, so set apart, should be taken into
account, in computing the capital of the company for the purpose of
Super· Profits Tax Act, 1963. It may be noted that in the Act itself
the expression 'reserve' has not been defined.
F
In the case of Commissioner of Income-tax, Bombay City v.
Century Spinning and Manufucturing Co. Ltd. (supra), this Court
had the occasion to consider the meaning of the word 'reserve'
while dealing with a case under Business Profits ·Tax Act (XXI of
1947). In this Act also, there were similar provisions with regard to
computation of the capital of the Company and the assessee had
G claimed that the amount recommended by the Board of Directors
and earmarked for payment of the dividend to the share-holders
should be treated as 'reserve' and should be taken into considera-
tion in computing the capital of the assessee. The Supreme Court
observed at pp. 503-504 as follows :-
H
"The term 'reserve' is not defined in the Act and we
must resort to the ordinary natural meaning as understood
VAZIR SULTAN TOBACCO v. C.I.T. (A.N. Sen, J.) 825

in common parlance. The dictionary meaning of the word A
'reserve' is :~

"I (a) To keep for future use or enjoyment; to
store up for some time or occasion; to refrain from
using or for enjoying at once.
8
(b) To keep back or hold over to a later time or
place or for further treatment.

6. To set apart for some purpose or with some end
in view; to keep for some use.
c
II. To retain or preserve for certain purposes
(Oxford Dictionary, Vol. VIII, P. 513.)

In Webster's New International Dictionary, Second
Edition, page 2118 'reserve' is defined as follows:
[)
I. To keep in store for future or special use; to
keep in reserve: to retain, to keep, as for oneself.
.,
2. To keep back; to retain or hold over to a future
time or place .
•
3. To preserve." E

The Supreme Court further observed at p. 504 : "What is the
true nature and character of the disputed sum, must be determined,
with reference to the substance of the matter?" The Supreme Court
held at p. 504-505 as follows :-
F
"A reserve in the sense in which it is used in rule 2 can
only mean profit earned by a company and not distributed
as dividend to the shareholders but kept back by the direc-
tors for any purpose to which it may be put in future.
Therefore, giving to the 'reserve' its plain natural meaning G
it is clear that the sum of Rs. 5,08,63'/ was kept in reserve
by the company and not distributed as profits and sub-
jected to taxation. Therefore, it satisfied all the requirements
of rule 2. The Directors had no power to distribute the
sum as dividend. They could only recommend as indeed H
they did, and it was upto the shareholders of the company
to accept that recommendation in which case alone the
826 SUPREME COURT REPORTS [1982] I s.c.R.

A distribution could take place. The recommendation was
accepted and the dividend was actually distributed. It is,
therefore, not correct to say that the amount was kept
back. The nature of the amount which was nothing more
than the undistributed profits of the Company, remained
unaltered. Thus the profits lying unutilised and not specially
B set apart for any purpose on the crucial date did not cons-
titute reserves within the meaning of Schedule II, rule 2(1)."
The Supreme Court also referred to S.131 (a) and 132 of the
Indian Companies Act. Referring to these sections the Supreme
Court observed at p. ·sos as follows :
c "Section 131 (a) enjoins upon the directors to attach to
every balance sheet a report with respect to the state of
company's affairs and the amount if any which they recom·
mend to be paid by way of dividend and the amount, if
any, which they propose to carry to the reserve fund,
D general reserve or reserve account. The latter section refers
to the contents of the balance sheet which is to be drawn
up in the Form marked F in Schedule III. This Form
contains a separate head of reserves. Regulation 99 of the
Ist Schedule. Table A, lays down 'that the directors may,
before recommending any dividend set aside out of the
profits of the company such sums as they think proper as a
E reserve or reserves which shall, at the discretion of the
directors, be applicable for meeting contingencies, or for
equalising dividends, or for any other purpose to which the
-
profits of the company may be properly applied ............... '
The Regulation suggests that any sum out of the profits of
the company which is to be made as a reserve or reserves
F must be set aside before the directors recommend any
dividend. In this case the directors while recommending
dividend took no action to set aside any portion of this sum
as a reserve or reserves. Indeed, they never applied their
mind to this aspect of the matter. The balance sheet drawn
up by the assessee as showing the profits was prepared in
G accordance with the provisions of the Indian Companies Act.
These provisions also support the conclusion as to what is
the true nature of a reserve shown in a balance sheet."
In the case of Commissioner of Income Tax v. Standard Vac-
H uum Oil Co. (') this Court had occasion to consider the decision in

(I) [1966] 59 I.T.R. 685.
VAZIR SULTAN TOBACCO v. C.l.T. (A.N. Sen, J.) 827

the case of Commissioner of Income-tax v. Century Spinning and A
Manufacturing Co. Ltd. (supra). Dealing with the said decision of
this Court held at p. 697-98 as follows :-

"The Court was dealing in this case with the accounts
of an Indian Company, tbe balance-sheet of which was
prepared according to the provisions of the Indian Cc>m- B
panies Act, 1913. Regulation 99 of the First Schedule,
Table A, required that reserves must be set apart before the
directors recommended any dividend but out of the profits
of the company no amount was set apart towards reserves
before the directors recommended payment of dividend to
the shareholders. The identity of the amount remaining on c
hand at the foot of the profit and loss account was not
preserved. It is on these facts that the court held that there
was no allocation of the amount to reserve and from the
mere fact that it was carried forward in the account of the
next year and ultimately applied in payment of dividend, it
could not be said to be specifically set apart for any pur- D
pose at the relevant date, i. e. the end of the year of
account."

This Court then proceeded to hold at p. 697-98 as follows :-

"We are in this case dealing with a foreign company E
and the system of accounting followed by the company is
different in important respects from the system which ob-
tains in India. Companies in fodia maintain diverse types
of reserves : such as capital reserve, reserve for redemption
of debentures, reserve for replacement of plant and machi-
nery, reserve for buying new plant to be added to the F
existing ones, reserve for bad and doubtful debts, reserve
for payment of dividend and general reserve. Depreciation
reserves within the limit prescribed by the Income-tax Act
or the Rules thereunder is the only reserve which is a per-
missible allowance in the computation of taxable profits. In
its ordinary meaning the expression 'reserve' means some- G
thing specifically kept apart for future use or for a specific
occasion.''

In the case of Metal Box Company of India Ltd. v. Their
Workmen, (') this Court while dealing with a case under the pay-
H
(1) [1963] 73 l.T.R. 53.

··~-
828 SUPREME COURT REPORTS [1982] I S.C.R.

A ment of Bonus .Act, 1965 had occasion to consider the expression
'reserve' and its meaning for the purpose of the said Act. This
Court held at p. 67-68 as follows :-
"The next question is whether the amount so provided
is a provision or a reserve. This distinction between a
provision and a reserve is in commercial accountancy fairly
B well known. Provisions made against anticipated losses and
contingencies are charges against profits and therefore, to
be taken into account against gross receipts in the P & L
account and the balance-sheet. On the other hand. reserves
are appropriations of profits, the asset by which they are

c represented being retained in form part of the capital em-
ployed in the business. Provisions are usually shown in the
balance-sheet by way of deductions from the assets in
respect of which they are made whereas general reserves
-
and reserve funds are shown as part of the proprietor's
interest (see Spicer and Pegler's Book-keeping and Accounts,
15th Edn. page 42). An amount set aside out of profits
D and other surpluses, not designed to meet a liability, con-
tingency, commitment or diminution in value of assets
known to exist at the date of the balance-sheet is a reserve ,
but an amount set aside out of profits and other surpluses to
provide for any known liability of which the amount cannot
E
be determined with substantial accuracy is a provision; (see •
William Pickles Accountancy, Second Edn. p. 192; Part III,
clause 7, Schedule VI to the Companies Act, 1958, which
derives provision and reserve."
In the case of Commissioner of Income-tax v. Mysore Electrical
Industries Ltd.(') the facts were briefly as follows :-
F Out of the profits of the company for the accounting period
ending March 31, 1963. the Directors of the company appropriated
the following amounts towards reserves on August 8, 1963 : (i)
Rs. 2,56,000 as plant modernisation and rehabilitation rese1ve : (ii)
Rs. 89,557 as development rebate reserve. The question was
whether these amounts could be included in computing the capital
G of the respondent as on April I, 191i3 under rule I of Schedule II to
the Companies (Profits) Sur-tax Act, 1964, for the purpose of the
statutory deduction for the assessment year 1964-65, The contention
of the c'epartment was that since the appropriations were made on
8th August, 1963 they could not be treated as components of capital
H as on the first day of the previous year i.e. !st April, 1963. Negativ-
(l) [1971) SO ITR 567.

I
I•·
VAZIR SULLAN TOBACCO v. C.l.T. (A.N. Sen, J.) 829

ing the contention of the department, this Court held that the deter- A
mination of the Directors to appropriate the amounts of the three
items of reserve on 8th August, 1963 bad to be related to first April,
1963, viz., the beginning of the accounts for the new year, and had
to be treated as effective from that day and the said three items had
to be added to the other items for computation of the capital
of the company as on first April, 1963 under rule 1 of B
Schedule II to the Companies (Profits) Sur-tax Act, 1964. It may be
noted that in this case before the trial court a claim had been made
by the company that a sum of Rs. 3,15,000 representing dividend
reserve was to be considered in computing the assessee's capital for
the purpose of Companies (Profits) Sur-tax Act, 1964 and the High
Court had rejected this claim. As against the rejection of this claim c
by the High Court, no appeal bad been preferred by the assessee to
the Supreme Court. The Supreme Court while considering the three
items which came up for consideration before it held, as already
noted, that the decision of the directors to appropriate the amounts
J
to these three items of reserve on 8th August, 1963 had to be related
to !st April, 1963 and this Court observed at pp. 560-570 as D
follows:-

• "It is well known that the accounts of the company
have to be made up for a year up to a particular day. In
this cas~ that day was the 31st March, 1963. If it was
• reasonably practicable to make up the accounts up to the
E
31st March, 1963, and present the same to the directors of
the respondent on April 1, 1963, they could have made up
their minds on that day and declared their intention of
appropriating the said and other sums to reserves of diffe-
rent kinds. But the fact that they could not do so for the
F
simple reason that the calculation and collection of figures
of all t11e items of income and expenditure of the company
for the year ending 'March 31, 1962, was bound to take
some time cannot make any difference to the nature or
quality of the appropriation of the profits to reserves as
determined by the directors after the first of April, 1963.
G
Their determination to appropriate the sums mentioned
to the three separate classes of reserves on the 8th August,
1963, must be related to the !st of April, 1963, i.e., the
beginning of the accounts for the new year and must be
treated as effective from that day".
B
830 SUPREME COURT REPORTS [1982] I S.C.R.

A Relying on the aforesaid decisions and also many other
decisions of the various High Courts which have been considered by
my learned brother Tulzapurkar, J. in his judgment, the learned
counsel for the assessee has argued that the word 'reserve' which
has not been defined in the Act, has to be understood in its ordinary
meaning as laid down by the Supreme Court in the case of Century
B Spinning Mills Ltd. The further argument is that the recommenda-
tion for dividend by the directors of the Company does not creat
any kind of liability, immediate ot future. It is argued that the
•
obligation to pay the dividend only arises when the shareholders
at the Annual General Meeting of the Company decided to accept
the recommendation of the Directors and pass a resolution for
c declaration of dividend. It is submitted that it is open to the
I>irectors to withdraw or modify the recommendations made by
them any time before the shareholders accept the recommendations
and in support of this contention reference is made to the decision
of this Court in the case of Keshoram Industries and Cotton Mi//s
Ltd. v. Commissioner of Wealth Tax (Central), Calcutta.(') and
D reliance is placed on the following observations at p. 772 :-

"The directors cannot distribute dividends but they
can only recommend to the reneral body of the company
the quantum of dividend to be distributed. Under
section 217 of the Indian Companies Act, there shall be
E
attached to every balance-sheet laid before a company in
general meeting a report by its board of directors with
respect to, inter alia, the amount, if any, which it recom-
mends to be paid by way of dividend. Till the company
in its general body meeting accepts the recommendations
F and declares the dividend, the report of the directors in
that regard is only a recommendation which may be
withdrawn or modified as the case may be. As on the
valuation date nothing further happened than a mere
recommendation by the directors as to the amount that
might be distributed as dividend, it is not possible to hold
that there was any debt owed by the assessee to the share-
G holders on the valuation date."

It is further argued that it is open to the share-holders to accept the
said recommendations in its entirety or to modify the same by

H (I) [1966) 59 !TR 767.
VAZIR SULTAN TOBACCO v. C.LT. (A.N. Sen, J.) 831

deciding to declare dividend at a rate lower than the one recom· A
mended by the directors. It is, therefore, contended that the
recommendation of the directors for payment of dividend does not
have the effect of creating any kind of liability and there is no .
debt owed by the company by virtue of the said recommendations.
It has been submitted that the decision of this Court in the case of
Mysore Electrical Industries Ltd. (supra) is of no assistance and the
8
said decision does not. lay down that in the event of the share-
holders' acceptance of recommendation made by the directors for
the distribution of dividend to the share-holders of the company,
the liability for payment of the dividend will also relate back; and
the doctrine of relation-back applies only in respect of items which
the directors are competent to decide for themselves, in view of
c
the process involved in the preparation of accounts of the
company.

J The main argument advanced on behalf of the Revenue is
that any amount which may be set apart for payment of dividend D
recommended to be paid by the Directors cannot constitute 'reserve'
within the meaning of the Act.

The argument advanced on behalf of the assessee appears to
• be sound; but to my mind the said arguments are not snfficiently
convincing to lead the Court to the conclusion that the amount set E
apart for payment of dividend recommended by the Board of
Directors can constitute 'reserve' within the meaning of the Act
for the purpose of computation of the capital of the Company.

The word 'reserve' bas not been defined in the Act. In the
absence of any such definition the word has to be understood in its
F
ordinary sense. It is, however, to be remembered Jthat the word
'reserve' in the instant case occurs in a taxing statute specially
applicable to Companies only. The word 'reserve' should be so
construed as to give the said word the meaning in which it is
ordinarily understood by persons interested in Companies or in
G
dealing with Companies. In other words, the word 'reserve' for
the purpose of this Act should be understood in the sense in which
it is understood in company circles and by persons interested in
Companies and in dealing with Companies. It may be noticed
that while considering the true meaning and true nature of'reserve',
H
the Supreme Court in the case of Commissioner of Income Tax v.
Century Spinning and Manufacturing Co. Ltd. (supra) has referred

•
i
832 SUPREME COURT REPORTS (1982] I S.C.R.

A to S. 131 (a) and 132 of the Indian Companies Act, to the Form
marked F in Schedule III in which balance sheet of the Company
has to be prepared and also to Regulation 99 of the First Schedule,
Table A. I have earlier quoted the relevant observations of the
Supreme Court.
B
It is, no. doubt, true that the recommendations of the
Directors for payment of any dividend does not create any kind
of liability for the payment of the said amount. The liability for
payment of any amount by way of dividend only arises when the
c share-holders accept the recommendations and a dividend is declared
at the annual general meeting of the Company. ' It is open to the
Directors to modify or withdraw the recommendation with regard
to the payment of dividend before the said recommendation is
accepted by the share-holders. It is also open to the share-holders
not to accept the recommendation of the Directors in its entirety
D and to modify the same. The legal liability for the payment of any
dividend only arises after the share-holders at the annual general
meeting have decided to declare a dividend on the basis of the
recommendations of the Directors or on the basis of any modifica-
tion thereof. The liability for the payment of dividend only arises
after the dividend has been declared by the share-holders at the
annual general meeting and this liability does not relate back to
•
E
any earlier date on the basis of the recommendations of the
directors, as the directors do not enjoy any power of declaring the
dividend. The amount that may be set apart for payment of any
dividend on the basis of the recommendations made by the Directors,
cannot be considered to be an amount set apart for meeting a
F known or existing liability.

Though the amount which is set apart for payment of any
dividend recommended by the Board of Directors is not an amount
set apart for meeting any known or existing liability, yet the said
amount so set apart cannot be considered to be a 'reserve' within
G the meaning of the Act for the purpose of computation of the
capital of the Company.

S. 210 of the Companies Act, 1956 specifically provides that
H at every annual general meeting of a Company the Board of Direc-
tors of a Company shall lay before the Company the balance sheet
of the Company and. also the Profits and Loss account. S. 2ll
VAZIR SULTAN TOBACCO v. C.l.T. (A.N. Sen, J.) 833

further provides that every balance sheet of a Company shall give a A
true and fair view of the state of affairs of the Company as at the
end of the Financial Year and· shall, subject to the provisions of the
section, be in the form set out in Part I of Schedule VI, or as near
thereto as circumstances admit or in such other form as may be
approved by the Central Government either generally or in a parti-
cular case. The preparation of a balance sheet in the prescribed B
form and laying the same before the share-holders at the annual
I
meeting are statutory requirements which the Company has to
observe.

Regulation 87 of Table A in Schedule I provides :
c
"(I) The Board may, before recommending any divi-
dend, set aside out of the profits of the Company such
) sums as it thinks proper as a reserve or reserves which
shall, at the discretion of the Board, be applicable for any
purpose to which the profits of the Company may be
D
properly applied, including provisions for meeting contin-
gencies or for equalising dividends; and pending such
application, may at the like discretion, either be employed
• in the business of the company or be invested in such
investments (other than shares of the Company) as the
E
Board may from time to time, think fit.

(2) The Board may also carry forward any profits
which it may think prudent not to divide. without setting
them aside as a reserve".
F

- This Regulation contemplates that the Board may set aside out of
the profits of the Company such sums, as it thinks proper, as a
reserve or reserves which shall, at the discretion of the Board, be
applicable for any purpose to which the profits of the Company may
be properly applied including the provisions for meeting contin- G
gencies or for equalising the dividends, before recommending any
dividend. In other words, the sums out of the profits of the Com·
pany have to be set apart as reserve before any dividend is
recommended by the Board; and the recommendation of the Board
for payment of dividend comes only after the creation of reserve. H
The amount that may, therefore, be set apart for payment of
dividend recommended by the Board is an amount which is set apart
834 SUPREME COURT REPORTS [ 1982] I s.c.R.

A after the Board had created the re•erve. The form of balance sheet
referred to in S. 211 of the Companies Act, 1956 is appended in
Part I of Schedule VI of the Statute. In the statutory form there
are various heads including heads of various kinds of reserves and
also of provisions. In the balance sheet of the Company which has
necessarily been prepared in accordance with the provisions of the
B statute and in the form prescribed, the amount recommended by the
Board for payment of dividend has been shown under the head
provisions and not under any head of reserves. It is, no doubt,
true that the true nature and character of the sum so set apart must
be determined with regard to the substance of the matter. The
substance of the matter clearly appears to be that the amount is set
c apart for payment of dividend recommended by tbe Board to be
paid to the share-holders and the said amount is never intended to
constitute a reserve of the Company. Indeed a provision is made
for payment of the said amount to the share-holders by way of
dividend on the basis of the recom_mendation made by the Directors.
Though in law the recommendation made by the Directors for
D
payment of dividend to share-holders does not create any liability
for the payment of dividend and liability only arises when the share-
holders accept the said recommendation, and though in law it may
be open to the Board to modify or withdraw the :·recommendation
with regard to the ~payment of dividend before the acceptance by
the share·holders and it may also be open to the share-holders not
•
E
to accept the said recommendation in its entirety and to modify the
same, yet. for business pusposes, when the directors make any
recommendation for payment of dividend and set apart any amount
for the payment of dividend so recommended, the directors intended
to make a provision for the payment of dividend recommended by
F them and not to create any reserve, as the Directors very well know
that the recommendation made by them with regard to the payment
of dividend is not normally up-set by the share· holders and it is
generally accepted by the share-holders, as a matter of course. Any
amount set apart by the Directors for payment of dividend to the
•
share-holders recommended by them, is understood by persons
G interested in company and in dealing with companies to mean a
provision for the payment of dividend to the share-holders and is
not understood to constitute a reserve. In my opinion, this true
nature and character of the sum so set apart are reflected in the
provisions of the Companies Act and more particularly in the
H manner of preparation of the balance-sheet of the Company. I am,
therefore, of the opinion that the amount set apart for the payment
VAZIR SULTAN TOBACCO v. C.l.T. (A.N. Sen, J.) 835

of any proposed dividend on the basis of the recommendation :or A
the Directors cannot constitute reserve for the purpose of computa-
tion of the capital of the Company. The view that I have taken,
to my mind, appears to be in accord with the view earlier expressed
by this Court in the decisions to which I have already referred.

On the other questions, I entirely agree with the view expressed B
by my learned brother Tulzapurkar, J. and I agree with the Jo rd er
proposed by him.

C.A. No. J614(NT)/78, Review Petition
No. 57/80 and Tax Reference Caoes c
Nos. 2&3/77 and 5/1978
dismissed.
P.B.R. C. A. No. 860/73 partly allowed.
j